It’s crucial you understand the different markets within a certain area. A good place to start is by breaking your market into six different price levels. What this refers to is the retail price within a certain area. Here are the different price levels you might consider:
Obviously, price levels will vary from one market to another. In Southern California, the price levels are much different than in the Midwest. It's up to you to adjust the prices according to the market you invest in.
A level one area is what is consider a “low-income” area. Theses areas tend to be high rental areas due to the low prices (under $100,000). These are the least desirable areas for homeowners to live. You should consider a level one area very risky for a few reasons:
Example: Here's what might happen with a level one area deal. You buy for $20,000, put $10,000 into the rehab, and contract to sell it for $55,000 to a retail buyer (FHA) after only one week on the market! Unfortunately, your appraisal comes in at $32,000! When examining the comps, there are several REO sales at $30,000 and under and there were no retail comps above $32,000 that meet FHA requirements. Always know the comps before you buy.
Investor Mistake: Why do a lot of new investors try flipping houses in the price level one areas? They do it for one primary reason - low capital investment. They start out saying, “I have $50,000 from my IRA (or whatever) and I can buy a house for $30,000, put $20,000 into repairs and then sell it for $80,000.” Although that sounds good on paper, when you understand the ramifications of a level one area, it becomes a very risky investment. It’s better to raise the capital and go into a higher level area to flip houses.
Levels two to four may spread from $100,000 to $300,000 in your area. This is where the largest segment of buyers are found. Levels 2-4 include first time buyers as well as downsizing buyers. You should consider levels 2-4 to be the ideal levels to flip houses. However, do to the price range, these levels are still mostly FHA buyers so you must be prepared to deal with FHA flipping guidelines, appraisals, and all of the ins and outs of FHA loans. This is where you should do 90% of your flipping.
Levels five and six are the $300,000 and up priced homes. The challenges with flipping these homes is that these are typically bigger homes, longer rehabs, more capital intensive, longer time on the market, and fewer buyers. But, the tradeoff is you have a more qualified buyer now (conventional instead of FHA) and you have a higher profit potential. You can make a lot more money per deal at price levels 5-6.
Beginning rehabbers are smart to start in the level 2 - 4 range and gradually move up to levels 5 and 6 when the market supports sales of more expensive homes and the rehabber has some experience.
Please leave a comment if this article was helpful or if you have a question.
Author bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.